Big Trouble, Potentially, for Little Colleges
Tuition-driven institutions with small endowments are most vulnerable to the economic downturn, Moody's report finds.
Wealthy research institutions may be able to weather the economic downtown by delaying building projects and forgoing faculty raises, but a subsection of cash-strapped private colleges could be in serious trouble, according to a report released Thursday by Moody’s Investors Service.
The economic crisis is particularly acute for colleges that relied upon potentially risky bonds to finance projects, and have few revenue streams other than tuition to pay off debts from those bonds, according to Moody’s, a bond rating agency.
Colleges that were lured by the low interest rates of variable rate bonds for capital projects, for instance, could now see interest rates spike, Moody’s reported. Even more problematic, however, is the possibility that bleak economic conditions will force banks to take the extraordinary step of demanding full bond payments on highly accelerated time lines. In some cases, bonds that colleges expected to pay out over 30 years could be due in three to five years -- or even a matter of days, says the report.
John Nelson, managing director of Moody’s, explained that the inherent risks of variable rate bonds have always been known. On the other hand, the possibility that banks would demand speedy repayment has historically been considered extremely remote -- until now.
“The way the market has functioned in the past, nobody ever demanded the repayment [this quickly],” Nelson said.
Moody's has not seen banks push yet for accelerated payments, but the agency expects that to happen if the credit markets remain as troubled as they are now for an extended period of time.
"There are a lot of bonds that are now held by banks [instead of investors]," Nelson said. "We know they have them; we know they can't remarket them."
“Nobody wants these bonds now,” Nelson added.
Colleges with large endowments and high bond ratings have a safety net. Those institutions will probably be approved to borrow more money to pay off bonds that are due on accelerated time lines, Nelson said.
Problems may arise, however, for expensive colleges with relatively small endowments -- substantially below $100 million -- that rely heavily on tuition revenue. Those colleges may find themselves with unexpected payments due on variable rate bonds and difficulty finding the loans they'd need to pay up.
In addition to the trouble they may have obtaining loans, high-priced colleges could also see their tuition revenues decline, according to Moody's. While the economic downturn may not dissuade students from going to college altogether, “we expect there may be a larger shift to lower cost alternatives” like public universities or community colleges, the Moody’s report asserts.
For tuition-dependent colleges that are deeply involved in now-risky bonds, the only way to stay afloat in the face of falling enrollments may be to sell off stocks or press donors for one-time major gifts, Nelson said.
Donors, hoping to see their gifts live on, aren’t necessarily accustomed to cutting checks just to bail out an institution. In some cases, however, that may now be necessary, Nelson said.
“The gift would be spent,” he said. “This would be pure philanthropy.”
Some colleges may not be so lucky to find a big donor, and a number of experts now predict a pending spike in the number of tuition-driven colleges that are forced to close or merge.
A Common Problem
In a cruel irony, some colleges are having trouble accessing the money they already have -- just when they need it most.
About 200 of the 500 colleges rated by Moody’s now have money that is frozen in the Commonfund, a non-profit corporation that offers pooled investment funds for colleges in the U.S.
“For some schools, this was the equivalent of their checking account,” said Roger Goodman, vice president and senior analyst at Moody’s. “This is where they kept their operating funds.”
Colleges that were deeply invested in Commonfund have already had to utilize credit lines and tap endowments, Goodman said.
Moody’s: Most Colleges OK
While there’s no single economic issue that stands to cripple colleges, the confluence of frozen assets, unexpected debt obligations and potential enrollment declines is causing a unique squeeze, say Moody’s analysts.
Since colleges are often more insulated than other institutions from the true perils of budget shortfalls, it’s notable that even a small sector of higher education appears to be in trouble, Nelson said.
“We’re not concerned about the vast majority of colleges,” he said. “That message can’t get lost. The vast majority of colleges are going to be fine. But for any of them to be in financial stress is kind of news.”
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